Tax Audit Horror Stories: What To Do When The Unthinkable Strikes

NEW YORK (MainStreet) — For Shauna Wekherlien, the owner of Tax Goddess Business Services PC in Scottsdale, Ariz., the scariest tax audit she saw was a corker, including threats from the Internal Revenue Service and a dash of ignorance and hostility.

“This client was in manufacturing,” she says. “They sent out a young auditor, who CPAs refer to as ‘iPod auditors’ because during the whole audit all they do is listen to their iPods. This auditor came in and asked for bank statements — a very normal thing for an auditor to do. However, in this instance, the auditor kept telling the client that he was missing the November bank statement. Of course, the auditor had the November bank statement, but didn't understand the bank statements didn't close exactly on the first of each month and end on the 31st of each month.”

That led to further problems, Wekherlien says.

“The auditor actually threatens my client, saying that if he did not provide the November bank statements he would have the ‘entire IRS come down on him so hard that he wouldn't know what hit him.’ It was at this point that we requested a new auditor. When you have an auditor doesn't know how to read bank statements, you know you're in trouble,” she says.

Sometimes, a tax audit horror story doesn’t point the finger of guilt at the big, bad, IRSm but on “toxic” tax professionals.

“We have had a couple of matters — one involving a forge company and another one in general manufacturing — where each had hired ‘tax professionals’ who represented them in examinations,” says Walter Harris, a former IRS executive and current director of IRS practice and procedure at New York City-based Alliant Group, a tax services firm. “In both cases, the examinations went south because of poorly prepared materials, unreasonable arguments and tax positions that obstructed the IRS personnel.”

For the tax client, the fallout was huge, and not in a good way.

“The impact was exposure to extensive tax liabilities, each in the mid-six-figure range,” Harris adds. “When we were hired to come in and help, we had to rebuild the arguments from scratch and look for offsets. It’s not always easy to regain the confidence of the audit team, particularly when they have been so frustrated to that point in the examination.”

What can taxpayers do if they’re in the IRS’ line of audit fire? Once again, we have enlisted the help of an all-star lineup of tax specialists:

Tax Goddess’ Wekherlien

To handle an IRS auditor, taxpayers should:

Always make sure you have protection. Contact the tax attorney, a CPA or an enrolled agent to help you and represent you during an audit.

Make sure you ask the person you have chosen to work with if they have ever worked on an audit for your particular needs. If they say yes, ask them if they won; if they say yes to that, ask to speak with that former client to get a good reference for that professional.

Always make sure that you have good books and records. I highly recommend you keep all of your receipts at least seven years. I also recommend you hire a professional bookkeeper to handle the preparation of your books and records. Even a small business can get into trouble and lose an audit if they don't have the proper documentation.

Alliantgroup’s Harris (on finding good professional help tax help for an audit)

The key takeaway is that a qualified audit representation team should be not only knowledgeable on taxes, but also skilled in building out the information and preparing a persuasive presentation of the facts and law, as well as seeing the matter through the administrative process and, if necessary, the courts.

We find that in many cases prior tax professionals:

Failed to be educated and understand the examination process as it relates to planning, execution and resolution of the audit, resulting in an unpleasant, disjointed, stress-filled and distrustful interaction with the audit team.

Failed to be pro-active and engage the audit team, which proved to be against the best interest of the taxpayer and would have produced a less than desirable result had they not reached out to different representation.

The key, Harris, is finding a tax professional who knows how to work with the IRS, who can engage in full “transparency” with the auditors (the IRS loves transparency, he says) and who is open to seeing things through the lens of the IRS. Do that and you’re well on your way to surviving an audit.

Federal and state tax offices send out huge numbers of notices advising taxpayers they owe money. Most result from simple data or reporting errors the tax authorities believe you made; if you gathered your tax information carefully and had someone competent prepare your return, there is a good chance the notice is incorrect.

Do not just pay the bill. Check the facts first, or ask your tax preparer to investigate. If the tax authorities’ figure is wrong and yours is correct, you should be able to clear up the matter without difficulty.

With field audits, when the IRS or your state agency goes through your records with a fine-toothed comb, the situation is far more complex and you may have more cause to worry

Field agents may seem to make up rules that are not in the tax code or regulations. That’s because they are typically some of the least-experienced and least-trained personnel on enforcement staff; those with greater knowledge tend to be promoted to review-level positions.

The audit process works best when it is limited to issues the auditor raises. An effective taxpayer representative (usually a CPA, attorney or IRS-authorized enrolled agent) will find out what the auditor wants to know, gather the information and present it clearly and concisely without triggering collateral issues — and often without you present.

Remember, skilled professional representation is expensive, and your representative does not control how many hours the audit will consume — the auditor does. Auditors do not care how much they cost you in professional fees. Sometimes tax authorities seem to have a pretty good idea how much it will cost a taxpayer to appeal or litigate a dispute and offer to settle for about the same amount. It may be worth accepting such an offer if the auditor raises a valid point.